Adrian Douglas: Manipulative derivatives in gold and silver keep growing

Section:

By Adrian Douglas
Saturday, June 27, 2010

The U.S. Treasury's Office of the Comptroller of the Currency (OCC) has just released the first-quarter 2010 bank derivatives report, which can be found here:

http://www.occ.gov/ftp/release/2010-71a.pdf

This report contains more evidence that a flood of paper gold and silver instruments are being used to divert investor capital away from the purchase of the actual physical metals in order to suppress prices. Before looking at gold and silver specifically, there are some other very important points to be noted in the report:

-- The notional value of derivatives held by U.S. commercial banks increased $3.6 trillion in the first quarter, or 1.7 percent, to $216.5 trillion compared, to Q4 2009. The notional value increased 7.1 percent from Q1 2009.

-- U.S. commercial banks reported trading revenues of $8.3 billion in the first quarter, 15 percent lower than $9.8 billion of revenue in the first quarter of 2009.

-- Derivative contracts remain concentrated in interest rate products, which comprise 84 percent of total derivative notional values. The notional value of credit derivative contracts, at $14.4 trillion, represents 7 percent of total notionals. Credit derivatives increased by 2.3% during the quarter.

-- Five large commercial banks represent 97 percent of the total banking industry notional amounts and 86 percent of industry net current credit exposure.

So there has been an increase of $3.6 trillion in notional value of derivatives in just three months!

... Dispatch continues below ...



ADVERTISEMENT

Prophecy to Become Coal Producer This Year
with 1.5 Billion Tonnes of Resource

Prophecy Resource Corp. (TSX.V: PCY) announced on May 11 that it has entered into a mine services agreement with Leighton Asia Ltd. to begin coal production this year. Production will begin with a 250,000-tonne starter pit as planned in August, with production advancing to 2 million tonnes per year in 2011. Prophecy is fully funded to production and its management team includes John Morganti, Arnold Armstrong, and Rob McEwen.

For Prophecy's complete press release about its production plans, please visit:

http://www.prophecyresource.com/news_2010_may11.php



It sure looks like the banks are working hard to reduce risk and avoid a reoccurrence of the financial meltdown of 2008 that was caused by the failure of Lehman Brothers and AIG due to their monstrously oversized derivatives books! This increase of $3.6 trillion in Q1 is greater than the entire gross domestic product of the United States in Q1!

It also looks like the regulators are working hard to make sure that the risks are not concentrated in a few banks that are "too big to fail," what with five U.S. banks holding a mere 97 percent of all banking industry derivatives!

It is ominous that derivative holdings increased 7.1 percent year-on-year while bank trading revenues decreased 15 percetn. Has the limit of the law of diminishing returns been exceeded?

Let's have a look at the gold and precious metals derivatives and compare Q1 2010 to Q4 2009:

The gold derivatives of all maturities increased by $7.8 billion (7.8 percent) to $107.7 billion. Some $6.8 billion of the increase was in gold derivatives of less than one year maturity. JPMorgan Chase increased its gold derivative holdings by $2.1 billion (2.5 percent) while HSBC increased its gold derivative holdings by a mind-boggling $6.1 billion (37.9 percent). (The HSBC holding is inferred, as its holding is listed under "other commercial banks," but as JPM and HSBC have traditionally held more than 95 percent of the precious metals derivatives it is reasonable to conclude that the other commercial bank category is almost entirely made up of the HSBC holding.)

The increase in gold derivative notional value in Q1 is equivalent to 40 percent of all gold mined in the world during the quarter.

The precious metals (silver) derivatives of all maturities increased by $0.9 billion (6.9 percent) to $13.7 billion. The silver derivatives of less than one year maturity increased by $1 billion (8.7 percent). The holdings of JPM in silver derivatives of all maturities increased $1.7 billion (22 percent) while those of HSBC decreased by $0.8 billion to $4.25 billion (-15 percent). The increase in notional value of silver derivatives held by JPM represents approximately 100 million ounces, which is 57 percent of the global production of silver during the quarter.

The entire notional value of silver derivatives of maturities of less than one year is $12.6 billion. This represents 745 million ounces of silver. It is relevant to compare the derivatives that expire in less than one year with annual global silver production; the notional value is equivalent to 106 percent of annual global silver production!

Two bullion banks, JPM and HSBC, continue to dominate the precious metals derivatives market with positions that are outrageously oversized compared to the underlying metals markets.

On Friday members of Congress who are negotiating the financial reform legislation came to a stunning compromise on a proposal by Sen. Blanche Lincoln to ban the banks from trading commodities and equity and credit default swaps.

http://uk.reuters.com/article/idUKN2527340820100625

Under the agreement banks can "continue to handle foreign exchange, interest rate, and gold and silver swaps and to hedge their own risks. Activity in cleared and uncleared commodities, agricultural, energy, and equities swaps, and credit would have to move to an affiliate within two years."

It is intriguing to say the least that the banks retain the right to continue to trade derivatives in gold and silver. This is almost a de-facto recognition that manipulating the gold and silver markets is a necessary function of the banking industry to keep the dollar Ponzi scheme running. But the manipulators are like King Canute ordering the waves back from the shore. The demand for real physical gold and silver in preference to paper and derivative substitutes is an investment theme that is gaining pace and is approaching like a tsunami. The suppression of gold and silver prices is doomed to fail and, in my opinion, in the very near future.

-----

Adrian Douglas is editor of the Market Force Analysis letter (www.MarketForceAnalysis.com) and a member of GATA's Board of Directors.

* * *

Join GATA here:

New Orleans Investment Conference
Wednesday-Saturday, October 27-30, 2010
Hilton New Orleans Riverside Hotel
http://www.neworleansconference.com/index.html

* * *

Support GATA by purchasing a colorful GATA T-shirt:

http://gata.org/tshirts

Or a colorful poster of GATA's full-page ad in The Wall Street Journal on January 31, 2009:

http://gata.org/node/wallstreetjournal

Or a video disc of GATA's 2005 Gold Rush 21 conference in the Yukon:

http://www.goldrush21.com/

* * *

Help keep GATA going

GATA is a civil rights and educational organization based in the United States and tax-exempt under the U.S. Internal Revenue Code. Its e-mail dispatches are free, and you can subscribe at:

http://www.gata.org

To contribute to GATA, please visit:

http://www.gata.org/node/16